The mortgage market will undergo radical change on Jan. 10, when virtually every aspect of home financing will be commandeered by the Consumer Financial Protection Bureau. The consequences of government overreach for creditors and borrowers will be all too predictable—more costly products and services, fewer options and, worst of all, the erosion of economic freedom.

The cornerstone of this new Dodd-Frank regime is a lender obligation to ensure that borrowers have the “ability to repay” a mortgage. This provision is also the basis of an expansive, new consumer right to sue creditors for miscalculating their financial fitness for a loan. Dozens of new servicing dictates also loom.

The costs of the regulations have been mounting for months, as creditors reconfigure policies and procedures, reprogram loan origination systems, retrain personnel—and hire consultants and lawyers to navigate 3,500 pages of rules. Even more daunting is the prospect of a further tightening of credit, which will reduce creditors’ revenue, undermine recovery of the housing market, and raise a barrier to the wealth creation associated with property investment.

The CFPB has issued some specific criteria for calculating a borrower’s ability to repay, but the bureau is also allowing some underwriting flexibility. This is both a benefit and a bane to creditors. On the one hand, lenders will enjoy some independence in designing ability-to-repay procedures. But it also means that there is no fixed compliance standard to follow, which invites arbitrary enforcement actions. As it is, the CFPB ranks among the most powerful—and unaccountable—agencies ever created.

Dodd–Frank offers a “safe harbor” from potential ability-to-repay litigation through a “qualified mortgage,” which entails loan limits, fee caps, and prescribed payment calculations, among other constraints. Of particular note is the QM requirement that mortgage payments will not increase the borrower’s debt-to-income ratio above 43%.

Although this ratio falls within the range of industry standards, there is infinite variety among borrowers’ circumstances that bankers could otherwise take into account. The DTI restriction will increase the number of applicants who will be rejected for loans they could afford. Some surveys also indicate that non-QM loans—those that might better serve buyers’ needs—will be difficult to come by.

Young adults will be among the hardest hit. As first-time homebuyers, they may have limited income and college debt, pushing their DTI above “qualified” status. But they are the very buyers who prompt churn in the market.

Creditors lobbied hard for the QM “safe harbor” as protection from the heightened litigation risk—which exists only because Congress created the new liability scheme to begin with. But there is also recognition that the safe harbor will not eliminate litigation risk altogether. Consumers will still be able to file lawsuits; only the scope of the litigation will be delimited. Meanwhile, a new prohibition on pre-dispute arbitration also is expected to increase litigation between borrowers and creditors.

The threat of litigation will understandably breed greater caution among lenders and thus further restrict the availability of credit. The impact will be particularly hard on smaller community banks that lack the capacity to increase their compliance staff or to hire consultants. Some are simply leaving the mortgage market.

The risks to lenders may be mitigated to some degree by meticulous compliance with the ability-to-repay procedures. But even the most vigilant lender will remain vulnerable because the regulatory parameters are fluid.

Even if a lender ultimately prevails in a legal challenge, it will not be spared the costs of litigation. The average cost to secure a motion to dismiss runs an estimated $26,000; summary judgment, $84,000; and trial, $155,000.

Creditors also face stiff penalties if their pool of borrowers is, by government standards, insufficiently “diverse.” But the QM rule, with its inflexible loan parameters, increases the likelihood that less affluent borrowers—and, consequently more minority borrowers— will not be eligible for a qualified mortgage.

In many ways, Dodd–Frank and the mortgage finance regulations it spawned resemble Obamacare. Both are attempts by Washington to control a complex and dynamic sector of the economy. If left unchanged, both will produce far more harm than benefit.

Diane Katz is a research fellow in regulatory policy at the Heritage Foundation in Washington.

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The democrats insisted that banks lend to people who couldn't otherwise afford mortgages.
The democrats wrote laws telling banks who they must lend to and they imposed quotas on banks.
Banks were forced by the democrats to lend to people that commercial prudence would have dictated dii not receive such loans.
All done in the name of so-called "fairness".
We got the worst financial crisis in the history of the planet, caused by democrats forcing bad loans to be made, and deliberately poisoning the entire capital market.
The democrats now insist that banks do not lend to people who cannot afford mortgages.
But now the democrats will now again force banks to lend to prescribed sectors of the population.
So the democrats are again deliberately interfering in the natural commercial operation of the market, after proving that they should not be allowed anywhere near markets, because of the global carnage that they wrought.
Maybe the democrats should stay the hell out of the economy - they don't understand it and are in no place to dictate terms of any sort to anyone on how it should work.

Posted by plume | Saturday, January 18 2014 at 1:46AM ET

Let me see if I can follow this thread:

"Creditors also face stiff penalties if their pool of borrowers is, by government standards, insufficiently 'diverse.' But the QM rule, with its inflexible loan parameters, increases the likelihood that less affluent borrowers -- and, consequently more minority borrowers -- will not be eligible for a qualified mortgage."

Is the author trying to forecast a future in which certain affluent, white borrowers may be denied a QM because the bank cannot find enough minority borrowers to do business with and does not want to face the attendant fines?

Is this some sort of nefarious plot to limit gentrification, or is it simply a bit of latent racism (minority = less affluent)?

Either way, I don't think that line will play too well in certain neighborhoods. But hey, if you think regulations can be predatory ... you probably won't make a lot of friends in any venue.

Posted by teknoscribe | Tuesday, January 07 2014 at 9:43PM ET

Article is very poor. But I am no fan of ATR either. Clearly the industry was not able to regulate itself, so something had to change. She merely attacks without advocating what needed to change. Like Obamacare? Mortgage lending is a lot less complex than the health care issue.

I think my major issue with ATR is that the consumer really didn't get anything out of it. If there was a simple disclosure for them, a cash flow that show their DTI and Monthly Cash Available at the end of the month if they take on the mortgage, the questions are simple - is this correct (is this your income and debts) and can you live on this? If they say yes and sign it...no liability for any of that. CFPB is old school regulator...needs to modernize...they don't understand software, automation and seem to not want to make the consumer responsible for anything.

But something had to be done. Same thing happened in securities market in the 30's...other markets as well, and here comes the regulation. Bush and company should not have loosened the reins so much.

Posted by AllRegs | Friday, January 03 2014 at 5:36PM ET

Here is what I think mortgage lending rules should look like, with credit to Dave Ramsey, plus one or two of my own ideas:
1. Eliminate Fannie Mae/Freddie Mac, along with all other federal meddling.
2. Prohibit the selling of mortgages. The bank that writes the loan must maintain the loan.
3. The borrower must:
a. Be completely debt free.
b. Have 6 months of living expenses saved up in an emergency fund.
c. put down 20% or more of the purchase price in cash, not using the emergency fund mentioned above.
d. take out no longer than a 15 year fixed-rate mortgage.
e. The mortgage payment should be no more than 25% of the borrowers take home pay.

There would not have been a mortgage crisis, housing crisis, foreclosure crisis, etc. with these rules in play.

Posted by mitw44 | Friday, January 03 2014 at 9:09AM ET

Lets look at the government's distortion of the mortgage finance system through the Community Reinvestment Act and the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac .
In a 2009 meeting with the Council on Foreign Relations, Barney Frank-the chair of the House Financial Services Committee and a longtime supporter of Fannie and Freddie-admitted that it had been a mistake to force homeownership on people who could not afford it. Renting, he said, would have been preferable. Now he tells us.
Long-term pressure from Frank and his colleagues to expand home ownership connects government housing policies to both the housing bubble and the poor quality of the mortgages on which it is based

Posted by Big Picture | Friday, January 03 2014 at 8:35AM ET

Well put, Winters.

This is such a biased take on some sorely needed bank regulation, with quite a bit of unnecessary editorializing. So much resistance, so little good sense.

Posted by fern36 | Thursday, January 02 2014 at 10:44AM ET

Lets not forget the events that led to Dodd-Frank. A serious financial crisis damaged the country's economy significantly. Remember the "Great Recession"? A large part of the reason for this crisis was predatory "financial innovation" by banks. Remember zero-down mortgages because financial innovation breakthrus enabled better risk mgmt? And those high-risk mortgages were repackaged into complex structured financial products that were marketed as no-risk/better return to municipalities, etc...? Remember bailing out with public money most of the financial institutions at the root cause? For that matter, remember robo-signing? My opinion: until the financial industry can earn back trust, which it squandered, it'll be facing regulation. Until we can be convinced that the financial industry poses little or no threat of requiring gigantic public bailouts again, public oversight of the industry will be necessary. The financial services industry bought this on itself. Let the innovators in the financial industry roll up their sleeves and keep their noses clean for 10 or 15 years, earning back trust and competing and innovating more on ways of allocating capital to business opportunities that need it as opposed to innovating to feather their own nests, and then we can talk.

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